Hayek, Greenspan And The Designs Of Men

Alan Greenspan has a piece in the Wall Street Journal today which essentially casts him as the Pontius Pilate of the financial crisis. Or, to sum it up rather sucinctly, “it wasn’t my fault”. You’re welcome to read through it and agree or disagree. However, the imporant point I think that should be taken from the Greenspan piece are the last two paragraphs:

Any new regulations should improve the ability of financial institutions to effectively direct a nation’s savings into the most productive capital investments. Much regulation fails that test, and is often costly and counterproductive. Adequate capital and collateral requirements can address the weaknesses that the crisis has unearthed. Such requirements will not be overly intrusive, and thus will not interfere unduly in private-sector business decisions.

If we are to retain a dynamic world economy capable of producing prosperity and future sustainable growth, we cannot rely on governments to intermediate saving and investment flows. Our challenge in the months ahead will be to install a regulatory regime that will ensure responsible risk management on the part of financial institutions, while encouraging them to continue taking the risks necessary and inherent in any successful market economy.

“The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.” — F.A. Hayek

Any columnist who starts with a Hayek quote is guaranteed to get my attention. And I’ve come to enjoy Oliver’s columns. However, reviewing Greenspan’s advice and admonitions in those two paragraphs, juxtaposed against the simple and elegant truth of Hayek’s statement you find yourself back in the outback watching that big red kangaroo headed for a collision with the car. It is inevitable, there’s nothing you can do about it, they can’t or won’t hear your warnings and all you can do is watch – and cringe.

Frankly, as we watch the machinations of government and listen to their declarations, we have begun to understand that for the most part, those in charge of all of this haven’t a clue. As Oliver states:

Far from demonstrating the demise of free enterprise, this long-running, deepening recession is revealing the limitations of government.

Government, in its various yet powerful incarnations, has been offering one fix after another since August 2007.

The more the Fed and Treasury have tried, the less sure they seem and the more nervous the money makers have become.

It’s understandable that folks would look to the new administration for new ideas. So it’s harder than usual to acknowledge that the ideas are in fact pretty old and, having been tried, found wanting.

Whatever one may think about the so-called stimulus, it’s too easily deconstructed as pork and policy initiatives.

And if it’s still debatable whether to nationalize the financial industry, the move to nationalize health care, education and energy can hardly be disguised as economic recovery programs.

It is understandable that those who derive their power from government would use this recession as an excuse to further government’s reach. But they act as if government has been absent — as if they’ve been absent — from the role of regulator and legislator.

He’s precisely right – it wasn’t a problem with lack of regulation or lack of legislation. It was a lack of proper regulatory oversight and a willful decision by legislators to ignore the building crisis coupled with government distorting the market and actually incentivizing risk taking far beyond that which is prudent that led us here. And now that they have us in this position, all of them, Greenspan included, are engaged in a flurry of finger-pointing and name calling at every one but the right ones. This wasn’t a crisis which happened in just the last 6 months or 8 years. This one has been building for a while.

“The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.” — F.A. Hayek

We had Democrats in charge and then we had Republicans. Again and again.

Both endorsed and encouraged the subprime sleight-of-hand. Both appointed heads of the regulatory agencies that could’ve stopped the poison seeping through our banks’ balance sheets. Both allowed gamblers to hedge and swap derivatives on top of derivatives that no one can explain and that are proving far more debilitating than the debacle they were insuring against.

Freddie Mac and Fannie Mae became toxic assets of the government while doing the bidding of congressmen who now act like the piano players in a brothel.

The Federal Reserve proved to be anything but reserved, instead stoking a fire that burned us all.

These were not the result of idle hands of government, but rather deliberate deeds that created false markets with inflated credit while turning a blind eye to those who finance election results.

Oliver’s characterizations are dead on – and he’s nailed both the fed and the Congress. The most irritating thing to me about this whole mess, other than the obvious huge loss of wealth, is the success those who were responsible for writing the rules, laying out the playing field and calling the game are escaping both blame and punishment for what they’ve brought about. That toad Barney Frank having the chutzpa to talk about prosecuting those who were guilty of getting us in this mess still astounds me. If anyone should be undergoing such prosecution right now, it is he and numerous other congressmen and women, both past and present.

Oliver concludes as follows and I can’t help but say a hearty “amen” to what he has to say:

We periodically recoil in horror at government’s failure to protect foster children or care for veterans or the mentally ill. But then we turn around and assume government will perform better in areas more complicated.

Why does the failure of government so often lead so many to believe we need more government?

Like the hair of the dog for the alcoholic, it may calm the trembling hands for a moment but it inevitably leads to another spree and another hangover.

Or worse.

We’re headed into a “or worse” moment. No one in government is going to listen to Alan Greenspan’s admonitions or believe Tom Oliver’s brief accounting of the history of this crisis. Instead we’re going to see precisely the opposite happen – more regulation, more strings, more intrusion, more control. And, as Hayek said, we’ll again see “how little [men] really know about what they imagine they can design.”

13 Responses to Hayek, Greenspan And The Designs Of Men

McQ – It was a lack of proper regulatory oversight and a willful decision by legislators to ignore the building crisis coupled with government distorting the market and actually incentivizing risk taking far beyond that which is prudent that led us here.

I keep hearing the phrase “lack of regulatory oversight”. Can you explain exactly what that means? What’s the difference between the government “regulating” or “overseeing” the financial industry, and meddling in it? What ought the government have done differently that would have averted this crisis other than stay out of the financial industry, housing market, etc?
To my mind, the government’s role should essentially be one of law enforcement, which is to say, mostly reactionary: a crime is committed, and the government should find, prosecute, and punish the criminal. Instead, the government has been proactive, and in ways not even calculated to deter actual crime (fraud, theft, etc), but rather to meet some feel-good political goal. “You must make loans to these people. You must follow these standards for determing who is eligible for a loan. We will underwrite the loans. We will determine what interest rates should be. Etc, etc, etc.” Now we’re trying to add more idiot meddling: “You can only pay your senior management so much per year. You can’t have a corporate jet.”

Can somebody explain to me how these rules make the financial industry more honest, accountable, or (dare I say?) safe?

Forgive me for being thick, but could you explain? Madoff, as I understand it, was a con man, a criminal. We could no more use “regulation” and “oversight” to stop his activities than we can use regulation and oversight to stop drug dealing, prostitution, theft, etc. Further, as I understand it, regulators suspected that Madoff was up no good but apparently couldn’t catch him: it wasn’t a lack of regulation, but rather a lack of action (rather like Pearl Harbor: radar saw the Japs coming, but nobody took action). Wiki has this to say:

The SEC investigated Madoff in 1999 and 2000 about concerns that the firm was hiding its customers’ orders from other traders, for which Madoff then took corrective measures. In 2001, an SEC official met with financial investigator Harry Markopolos at the SEC’s Boston office to go over Markopolos’s allegations that Madoff’s firm was engaged in fraudulent practices. The SEC also said it conducted two other inquiries of Madoff in the last several years, and did not find major problems. In 2004, after published articles appeared accusing the firm of front running, the SEC’s Washington branch cleared Madoff of that accusation… During the 2005 investigation, Meaghan Cheung, a branch head of the SEC’s New York’s Enforcement Division, was the person responsible for the oversight and blunder, according to Harry Markopolos, who testified on February 4, 2009, at a hearing held by a House Financial Services Subcommittee on Capitol Markets.

Again and again, the SEC regulators investigated Madoff, a respected figure on Wall Street since the ’60s… and didn’t catch him. Lack of regulation, or simply dealing with a very savvy and clever crook?

But let’s assume that regulators could have stopped Madoff by even more aggressively peering over his shoulder, routinely subjecting him to audits, and requiring him to fill out mountains of forms and reports. Would that have stopped him? And what effect would such intrusive government regulation have on other, honest businessmen? Is the cure worse than the disease?

Read up on the Madoff affair – it had zip to do with lack of regulation and everything to do with lax regulation. The regulatory environment was there to prevent it, the regulators were just asleep at the switch. That’s indicative of much of the problem we now face. It isn’t a lack of regulation – it’s a lack of regulators doing their jobs (oversight).

That’s my problem with it as well. What they won’t do is take a close look at why this all happened – that would require that their existing regulation regime would take a hit. Easier to blame a lack of regulation and tighten the screws – and control.

Another point: making subprime mortgages, bundling them, and selling them was legal, no? So, even an army of the most vicious, sharp-eyed regulators couldn’t have done anything to avert that problem. And why would Congress have made laws preventing that sort of thing? Quite aside from the fact that Congress and the past several administrations have been to a large degree complicit in creating the subprime mortgage mess, it would have required incredible foresight and a deep understanding of the markets for them to even consider regulating / banning such practices. The average member of Congress isn’t even bright enough to get graft without cover from MiniTru and his fellow crooks; expecting them to see that their own policies were leading to disaster would be a bit much.

Yes it was legal – but was it wise business? Well yes, if the government says it will back them through the two FMs. So who created and incentivized that market? Who distorted it? Without the vehicle provided by government (and all but guaranteed by it as well) which institutions go out on a financial limb?

The fact that these assets are bundled and then sold is not the issue. Real estate assets like these have been sold for years. The fact that these bundled assets were given AAA ratings which was a false indication of potential risk was what made them toxic. Investors were hoodwinked into buying a sows ear thinking it was a silk purse. Again it was not the lack of regulation but in the application or enforcement of the regulation.